Tuesday, March 9, 2010

Why Treasury doesn’t like principal write-downs

Well done to Shahien Nasiripour, who did the best job of anybody, at the Treasury blogger meeting yesterday, at getting Treasury’s officials to commit news. Specifically, he asked about Sheila Bair’s sensible idea that mortgage principal write-downs can help keep homeowners in their homes while also maximizing the value of the mortgage to the issuing bank. And he was told, quite clearly, that Treasury has been talking to Bair about this idea, and that if it makes sense at the bank level, it probably makes sense at the federal level, too, as part of the HAMP program to make mortgages affordable.

Except that once the meeting was over, its main architect, Treasury flack Andrew Williams, emailed Nasiripour to walk that particular idea back, saying that Treasury was NOT (his all caps) going to do anything “major” in terms of principal write-downs, and that any moves in that direction would be no more than “tweaks”.

At the dinner after the meeting, Williams did a good job of looking very interested while saying absolutely nothing as the assembled bloggers talked about the optimal treatment of bank balance sheets during a recession. Do you mark to market, thereby plunging the entire financial sector into insolvency, or do you delay and pray, risking a Japan-style lost decade?

It seems to me that insofar as Treasury has a problem with principal write-downs, that’s clearly a function of the fact that it’s worried about the consequences for banks’ balance sheets. We’re prosecuting a muddle-through strategy right now, where the government artificially props up house prices by providing substantially all of the mortgage finance in the country, in the hope that with economic recovery will come enough of a natural rebound in house prices to let the government slowly remove its support without them falling dramatically again.

A large program of principal write-downs would in effect ratify the view that house prices are not going to recover any time soon — and that’s not a view that anyone in Treasury wants Americans to have. A different senior Treasury official, trying to explain that the economy is doing much better than expected, told us in the meeting that house prices right now are higher than house-price futures were indicating a year ago. It’s a silly argument: house-price futures are highly illiquid, and they don’t give a remotely useful indication of where people expect house prices to be in the future, since insofar as they’re used at all, they’re overwhelmingly used to hedge existing long housing positions. Because there’s no one who naturally would want to take the opposite side of the trade, house-price futures always look very pessimistic.

In any case, it was clear that Treasury is trying to sell a message that the economy is doing much better than anybody had dared to hope this time last year. And since a program of principal write-downs would be incompatible with that message, it’s probably not going to happen.